March
15, 2012: Many have
questioned why, in the face of better and better
economic data since the Economic Cycle Research
Institute (ECRI) made their call
for a new recession last Fall, they have
maintained their recession call. This
article is their detailed answer.

Why Our Recession Call Stands

Many have questioned why, in the face of improving
economic data, ECRI has maintained its recession
call. The straight answer is that the objective
economic indicators we monitor, including those we
make public, give us no other choice.

Let’s start with the current state of the economy.
A couple of weeks ago, we publicly highlighted
ECRI’s U.S. Coincident Index (USCI). It’s
important to understand that the USCI isn’t a
random concoction of data, but rather the gold
standard for measuring current economic growth, as
it summarizes the key coincident economic
indicators used to determine the official start
and end dates of U.S. recessions; namely, the
broad measures of output, employment, income and
sales. So when USCI growth is in a downturn
(bottom line in chart), it’s an authoritative
indication that overall U.S. economic growth is
actually worsening, not reviving.

In contrast to the 3% GDP growth widely reported
for the latest quarter, year-over-year growth in
GDP, after peaking at 3½% in Q3/2010, has
basically flatlined around 1½% for the last
three quarters. Broad sales growth has followed a
similar pattern, while the growth rates of
personal income and industrial production have
dropped to their lowest readings since the spring
of 2010.

The exception to this weakening pattern is
year-over-year payroll job growth, which continued
to improve through January, and was essentially
flat in February. However, the empirical record
shows that job growth typically turns down after
downturns in consumer spending growth, not the
other way around. Because consumer spending growth
remains in a cyclical downturn, we expect job
growth to start flagging in the coming
months. But the point remains that the USCI,
which summarizes the definitive coincident
economic indicators – including jobs – indicates
declining growth in the U.S. economy.

How about forward-looking indicators? We find that
year-over-year growth in ECRI’s Weekly Leading
Index (WLI) remains in a cyclical downturn (top
line in chart) and, as of early March, is near its
worst reading since July 2009. Close observers of
this index might be understandably surprised by
this persistent weakness, since the WLI’s smoothed
annualized growth rate, which is much better
known, has turned decidedly less negative in
recent months. The unusual divergence between
these two measures of growth underscores a
widespread seasonal adjustment problem that
economists have known about for some time.

Most data, both public
and private, are seasonally adjusted. But the
nature of the Great Recession seems to have had
an unexpected impact on the statistical seasonal
adjustment algorithms that are hard-wired to
detect when the seasonal patterns evolve and
change over the years. This is normally a good
thing, but when the economy fell off a cliff in
Q4/2008 and Q1/2009, it was partly interpreted
by these procedures as a lasting change in
seasonal patterns. So, according to these
programs, data from Q4 and Q1 would be expected
thereafter to be relatively weak, and therefore
automatically adjusted upwards. Our due
diligence on this subject indicates a widespread
problem, resulting in many recent economic
headlines being skewed to the upside.

However, we have no way to
objectively measure the extent of these problems –
either the upward bias for Q4 and Q1 or the
downward bias for Q2 and Q3. Fortunately,
year-over-year growth rates are naturally less
susceptible to these seasonal issues because they
involve comparisons to the same period a year
earlier that is likely to be skewed the same way.
In contrast, smoothed annualized growth rates,
which we have traditionally preferred, presume
proper seasonal adjustment. While the extent of
the seasonal problem will be debated, monitoring
year-over-year growth rates is a matter of simple
prudence at this juncture not only for ECRI’s
indexes but also for other economic data.

In the chart, please note
the one-to-one correspondence between the cyclical
swings in the year-over-year growth rates of the
WLI and USCI since the Great Recession. Both
surged initially, only to roll over, pop up
briefly, and then turn down once again. It is
notable that the WLI, which is sensitive to the
prices of risk assets that have been supported by
massive worldwide liquidity injections, has hardly
been swayed from its recessionary trajectory. In
spite of the efforts of monetary policy makers,
actual U.S. economic growth has slowed, while WLI
growth has barely budged from a
two-and-a-half-year low.

The bigger question is, can
unprecedented, concerted global monetary policy
action repeal the business cycle? The objective
coincident and leading indexes that we have always
monitored are still telling us that it cannot.

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